Profit Target

Profit Target
See also
Baumol model Differential costing Total capitalization Marginal relief Profit Look-Ahead Bias Liquidity management Held to maturity securities Depreciation of fixed assets

The profit target is the price (place) specified on the chart, which determines when a withdrawal from strategic activity on the financial market is to take place, i.e. when all financial transactions are to be closed.   In other words, it is the size of a predefined profit (P. W. Farris; Bendle N.T.; Pfeifer P. E.; Reibstein D. J. 2010,p.68).

The target profit can also be defined as the planned profit from the budgeting period, which is possible to achieve in a specific time of the settlement period. The target profit is usually analogous to the real amount of the profit and loss account (P. W. Farris, N. T. Bendle, P. E. Pfeifer, D. J. Reibstein, 2010, p. 68). For this reason, sometimes there are differences between the profit target and the actual profit amount, which require an accounting analysis. Budgets at the end of the budget year are characterized by discrepancies and inaccuracies in settlements, so it is necessary to use rolling forecasts, allowing for current updates of data on expected profits. This enables a more accurate and probable determination of the profit target and reduces significant differences between the real and the target profit (P. W. Farris, N. T. Bendle, P. E. Pfeifer, D. J. Reibstein, 2010, p. 68).

Methods for determining the profit target

Cvp analysis

Cost-Volume Profit Analysis allows you to plan your cash flow and model your profit target. The CVP algorithm is as follows (B. Sorin, C. Scorte, 2011, p. 479):

To complement the profit target, multiply the expected number of units to be sold by their expected contribution margin to get the total contribution margin in a given period. Then subtract the total amount of the expected fixed cost for the period. This modified algorithm may be used to identify the following variables (B. Sorin, C. Scorte, 2011, p. 479):

• Changes in the amount and extent of the contribution for the effects of the transition to lean management
• Changes in fixed costs and outsourcing margins
• the determination of an adequate margin
• modelling the contribution per unit and units sold based on expected sales promotions.

Profitability threshold analysis

Profitability threshold analysis shall also be used in the method for determining the target profit. In this case, the company sets a price that allows it to achieve the target rate of return on capital employed (ROI, return on investment) (R. D. Stewart, R.M. Wyskida, J. D. Johannes,1995 p. 472-473). This method is used by enterprises whose activities require incurring high investment outlays, e.g. in the case of tourist activity it is mainly hotel industry, recreation services such as: bathing beaches, aquaparks, Thematic parks, transport services or gastronomy(A. Hing-Ling Lau, Hon-Shiang Lau, 2007, p. 392-408).

Applicability of profit target

The setting of a target profit allows to achieve the sales profitability expected by the company. In this case, it is also necessary to consider whether the product being introduced is a novelty or a mere modification of an existing product on the market (A. Hing-Ling Lau, Hon-Shiang Lau, 2007, p. 392-408).

When the product being introduced is new, the target profit shall be estimated either on the basis of the profitability rate determined for the company or on the basis of the average level of profit margin for the sector/industry in which the company operates (A. Hing-Ling Lau, Hon-Shiang Lau, 2007, p. 392-408).

${\text{ROS}}={\frac {Target\ profit}{sales\ revenue}}$

${\text{Target profit}}={{\text{ROS}}\cdot {\text{Revenue from sales}}}$

where:

• ${\text{Sales revenues}}={{\text{Target price}}\cdot {\text{Planned quantity of sold products}}}$
• ROS - Profitability on sales

When the input product is a modification of an existing product, the target profit is determined on the basis of the ROS calculated using the previous method adjusted for additional costs (e.g. research and development costs).

${\text{Target profit}}={{\text{ROS}}\cdot {\text{Proceeds from sales}}}$

References

• Farris, P. W., N. T. Bendle, P. E. Pfeifer, D. J. Reibstein, (2010), Marketing Metrics: The Definitive Guide to Measuring Marketing Performance
• Lau Hing-Ling A., Lau Hon-Shiang., (2007), Maximizing the Probability of Achieving a Target Profit in a Two-Product News Vendor Problem, 19(2), June
• Palia A. P., (2008), Profit Pricing With The Web-Based Breakeven Analysis Package, Developments in Business Simulation and Experiential Learning, Volume 35,
• Sorin B., Scorte C. (2011), The Profit Target In a Restauration Unit, December,
• Stewart R. D., Wyskida R. M., Johannes J. D., (1995), Cost Estimator's Reference Manual

Author: Marzena Rusin